Building a company is hard. Do it alone and you also find it’s an incredibly lonely place to be. I know this as I did it.
Instead of feeling down about that fact however, I spent my days and nights consoling myself that it was worth it. I owned 100% of the pie after all!
I thought it was smarter to have 100% of the equity. The whole pie. But I could not have been more wrong.
You see, the way to create true value and deliver on the promise that your business offers I’ll go as far as to say it’s almost IMPOSSIBLE to do it alone.
Going alone only gets you so far
Building a business, especially a service business, is all about people. Often an agency or start-up founder will be able to build a certain level of scale simply through their own specific skill or reputation. Often that secret sauce is focused on a proposition and unique piece of insight they have come to earn in a previous role or career.
The usual path then for an agency entrepreneur is to work that go-to-market up and start hitting the road with nothing more than a great story and a bag full of enthusiasm and experience to throw at it.
Often, then, they are the salesperson and rainmaker and take the business from zero to hundreds of thousands or low millions in turnover. Often this process happens relatively quickly and if it does it is the sign that the agency brand has true scaling capability.
This is not always the case of course as some leaders take a much more measured approach to early growth – and this is fine too. The point is not how quickly you get there but the fact that you did.
In doing so many different questions are asked of you. If you’re the sales rainmaker then how do you scale back office and operations to deliver the product at a level of quality that you produce and, in doing so, retain clients for the long haul?
And this is often where things start to get a little messy. Often front-of-house founders lack the detail focus required to deliver an enterprise-grade solution to delivery. They will also not have the bandwidth to do it and perhaps lack the experience to be able to solve it.
Those that can are often expensive. The usual course of action is to hire a midweight person to fill the gap and think that’s job done.
For a time, it may be. There will be some level of improvement, but to double, or treble top-line revenues you need someone who has been there and bought the tee shirt.
To keep and retain that level of experienced talent salary and bonus alone simply won’t cut it.
And, before you think it, neither will offering 2% of your equity.
The Principle of Generosity
So, how do you go about solving the conundrum? The answer lies in the Principle of Generosity; a way to reframe your belief system about what it takes to build a business sizeable enough to reward you properly.
But before we jump into the correct framing, let’s look at the usual thought process. Here’s how it usually goes…
You start a business with the aim of creating something you are proud of. And, often in the early days, as a vehicle to help you pay the bills and earn the money you need to pay for life’s necessities.
After a while you surpass that point and begin thinking about the process of building a ‘real business’; one which could, if the stars align, create life-changing money for you.
And this is the point at which the thinking goes slightly awry.
Delegation disease.
The natural approach here is to want to put your arms around your company and its ownership structure and ensure you have ‘as close to 100% as possible’ in the thinking that giving away equity is akin to giving away millions of your own cash.
It was a mistake I made early on. Instead of thinking long-term about how to build true scale and value, I was naive and short-sighted.
I believed that it was better to own 100% of something small, than a small amount of something large.
And therein lies possibly one of the biggest value destructors there is.
The issue of thinking you’ll do better by hogging all the equity is both self-limiting and damaging to the business you are trying to build.
It’s not too dissimilar to the issue of delegation, which can also be damaging, but to a lesser degree. Those earlier in the journey will hit a glass ceiling if they fail to delegate effectively and allow capacity to grow and the same is true when the business becomes a little larger – only that the resulting damage is much greater in the long term.
Why? Simply because it is very rare for a single founder to grow an agency past around £1m – £1.5m EBITDA (profit in plain speak). The job and resulting machine to deliver that kind of level of profitability is just too large and requires too much specialist skill and experience in key areas for it to be carried by one person.
Sure, that business may well be worth several million pounds – and to some that is more than enough. But not only is that self-limiting to you as the founder but also, as importantly, to the team that helped you build it. Surely, they deserve to be part of something truly scaled too.
The lost multiple returns
Going back to the value destruction point we can bring this to life much better with numbers.
Let’s say you are a single founder. Along the way to your £1m a year EBITDA agency business finish line you may have created a small share options pool for a couple of the key people that have joined the rocket ship with you. Those people have helped hold the ceiling up but don’t necessarily have real-life experience of growing past the point you are currently at.
Let’s say, for the sake of argument, they have 10% between them.
That leaves you with 90%. Sounds great, right?!
Your acquirers have been working on an offer. They are excited to present you with a Letter of Intent (the letter they send you outlining the overall offer and top-level terms before they go into Due Diligence). In it they detail the following:
You will receive £4m up front (what they call a 4x multiple) and any ‘free cash’ in the bank account on deal day.
There will then be a three year earn out where if you deliver significant growth to the bottom line, you could see another £2m.
And 90% of that is YOURS. Earn outs are notoriously difficult to deliver, but let’s imagine it went well and you see a total of £5m.
That’s £4.5m (before tax) to you personally. A great result in anyone’s book.
Your team share £500,000. A lot of money and welcomed, but not necessarily life-changing for anyone outside of you.
At the time you celebrate but, in the years, to come you’ll look back at it as a missed opportunity.
Why? Because it’s a rare thing to create a £1m a year EBITDA business and so with the opportunity why would you not build your business in such a way as to create a life changing event for many?
And the reality is you were so close.
The shame of it all is that larger, scaled businesses command greater multiples. The reason is very simple as those agencies past a certain size will have had to have built out such things as:
- A quality, experienced senior team. Often with more than one person capable of running the entire operation as part of a succession plan for the founder. This may even have already happened.
- A full ‘back office’ with finance, HR, IT and so on in place.
- World-class business intelligence dashboarding such key metrics as capacity, utilization, average fee per hour, win rate, upsell, and cross sell rates, project margin and so on.
Having done so there is a good chance the business’ financials will be much more ‘reliable’ and consistent, especially around the key areas of gross margin, operating profit, and revenue.
Impact on multiples
The impact building such things has on how your business is valued is huge. To understand it let’s run through an example again.
In building out a senior team and delivering the ‘back office’ improvements it means that you have added a further £1m to your EBITDA (earnings before interest, taxes, depreciation, and amortization).
Had you continued to be measured in the same way you were as a smaller business that would double your end return. Not bad.
But that same business will attract much more significant multiple of earning too, possibly as high as 10-12x, as opposed to 4x. So, for example, if we assumed the same deal as above at 12x EBITDA, the value looks more like this:
- 12 x £2m = £24m upfront + £12m earn out
- (vs 4 x £1m = £4m up font + £2m earn out)
As you can see this creates a massively different outcome for all, leaving more than enough room to create multiple millionaires and many happier senior employees.
My experience
We were lucky enough to enjoy a very successful agency exit, well north of the figure above, thanks to a brilliant senior team and the result was we managed to create 3-4 millionaires and a dozen or more life-changing payments outside of us as two founders.
And so, you start to see the point. On an exit of £32m holding just 15-20% would result in a better result for both you and those around you.
It really is better to own a small piece of a large business!
Scaling is not easy.
The problem is getting there is a very difficult task and one an inexperienced team simply cannot deliver.
So, how do you do that? Let’s look at the options.
Adding firepower
To get to a £20m+ exit as an agency owner you simply MUST do it with experienced help and allow them to take a chunk of your business. It’s a huge decision of course and so it pays to spend a lot of time understanding the strategic options available to you to do it.
In general, there are three ways to do it:
- Private Equity
Private Equity is an interesting, and growing, opportunity within the agency world. Even a few short years ago few groups would even look at service businesses due to the lack of tangible long-term value. But things are changing, and more and more are now looking to back agencies to help them grow.
The challenge here is that whilst the cash they can give you is helpful to grow through acquisition and so on, it can create as many problems as solutions. The top tier of PE helps here as they are staffed by very experienced people, often those that have exited huge businesses themselves.
These kind of PE ‘houses’ don’t operate in the agency space however and so it can be difficult to find a partner that can truly help, as well as fund your business.
- Mergers
A route that can provide value – and lots of learning opportunity – is one I took advantage of (mainly due to the lack of option 3.). Merging and taking a stake in a combined entity can help you both scale teams, channel expertise, improve your proposition and go-to-market and senior team quickly.
It is not without risk though. If, like me, you take a minority stake in a larger group then you must accept that you are losing control and not everything is going to be done the way you want it to. Culturally too you are gambling a lot as your key product is your people. If the cultures don’t align well then you risk everything.
If it does work though, you can come out of the other side on day one with a business of the kind of scale we discussed.
- A strategic investor
By far the best way to approach this is to find the right kind of experienced investor to come in with you. This is obviously not easy to achieve as often those people will have other interests or be in demand elsewhere. But, if you can find someone who has been there and bought the tee shirt and can invest cash too, then you really do end up with the best of both worlds. By selling a portion to them and getting them to work alongside you it creates a 1+1=3 scenario that benefits everyone within the business.
And so, the Principle of Generosity may well be the most underrated framework in the agency growth universe!
Less really can be more.
Want to know more about any of the above? Get in touch directly via hello@scaled.co.uk and we can chat you through the options available to you. We can also offer you a full support service, either through our consultancy or investment arms.
